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The Smartest Way to Play Energy Today

Even with the Deepwater Horizon spill contained, energy is still chaotic. But you need it.

My wife has a favorite financial writer, a distinction I'd be proud as a peacock to claim. But for better or for worse, the lucky fellow is The Wall Street Journal's Liam Denning, who recently penned the lead article for an energy report in the paper's "Power Investing" section.

A few Foolish thoughts on energy and the deepwater-drilling banI disagreed with few of the report's conclusions, I'm not here to reiterate or dissect the Journal's work. After all, we at The Motley Fool have minds of our own. So given my concern about the status of the energy industry in the United States -- along with my conviction that it remains our most important economic sector -- let me weigh in with some thoughts and let you know how investing Fools might best approach it. And I believe they must.

Obviously, the most important event in the world of oil and gas in 2010, and the most important in many decades, was the April explosion in the deepwater Gulf of Mexico, and the massive BP(NYSE: BP) oil spill that followed. And although the flow from the damaged well has been contained since July, we're now in an politically dictated drilling moratorium in the deepwater Gulf.

The halt has been mandated despite contrary judicial opinions and a record of nearly 4,000 Gulf wells having been drilled beyond 1,000 feet and 700 wells of 5,000 feet or greater -- all without a previous major spill. Further, about a third of U.S. oil production comes from the Gulf, and 80% of that is from the deepwater. Shallower drilling hasn't come through unscathed from the edict, either.

Emptying out the Gulf?So unless the moratorium is halted, more rigs will skedaddle from the Gulf to other world venues, where they'll surely remain for years. Our lot will be to become even more oil-dependent on other countries, many which are not our friends. On that basis alone, I become more convinced daily that geographic diversity, of the type that the likes of ExxonMobil(NYSE: XOM) and Chevron(NYSE: CVX) enjoy, is a key asset for oil and gas producers, and energy investors should take the factor into serious consideration.

Now we've got gas!The world of natural gas has changed dramatically during the past few years. From concerns about running out of the fuel, U.S. companies in particular have developed new drilling and production techniques to significantly increase its availability.

For instance, a combination of horizontal drilling and hydraulic fracturing, or "fracking," now facilitates the removal of gas from around hard rocks, or shale formations, far underground. Fracking involves pumping fluid (a mixture of water, sand, and chemicals) into the shale under sufficient pressure to cause fractures and allow the gas to escape.

The result, as you'd expect, has been a substantial increase in gas availability and a plunge in the prices it fetches, as such shale plays as the Barnett Shale in North Texas, the Haynesville Shale in Texas and Louisiana, and the Marcellus Shale in from New York to West Virginia improve their production.

And don't assume that potential natural-gas opportunities from shale are limited to the United States. There's no shale production in Europe yet, but it's next up. In fact, ConocoPhillips(NYSE: COP) has recently completed the first well in a shale formation in Poland, while U.S.-based Hess(NYSE: HES) has bought into a play in the Paris Basin owned by Toreador Resources(Nasdaq: TRGL). Meanwhile, closer to home, Canada's Talisman(NYSE: TLM) is teeing up to begin operations there early in 2011.

Environmental concerns about frackingHowever, a potential difficulty has reared its head for shale gas producers: concerns about contamination of water tables from fracking. Coincidentally, this week, the Environmental Protection Agency held hearings in Binghamton, N.Y. Its objective with the sessions, which apparently were packed with both pro- and anti-drilling contingents, was to attempt to determine the degree of danger that fracking really poses.

Somewhat surprisingly, fracking has been the subject of four documentary films, which line up right down the middle on which side they take. Gasland and Split Estate have depicted the technique negatively and blamed it for a variety of woes, including serious illnesses among those who live nearby. Haynesville and Gas Odyssey, on the other hand, have emphasized economic and other benefits resulting from shale production.

Power companies give it the gasNevertheless, the changing world of gas has allowed power companies throughout much of the world to alter their plants, such that they produce more electricity from gas and less from coal. The primary reasons for the switch are clearly the availability and price of gas -- which is lingering near $4 per million British thermal units -- and the substantially cleaner-burning qualities of the fuel in comparison with coal. As such, the companies' movement to gas is expected to accelerate for years to come.

Before closing, a few words about wind and solar power: Full-scale contributions from renewable energy will make a major contribution to our environment and the world's geopolitical relationships over time. To me, the difficulty appears to be that neither will be capable of making that level of contribution for many years to come. So even though I applaud the efforts aimed at the further development of these technologies, let's remain cognizant that, like it or not, we'll remain heavily dependent on hydrocarbons for decades to come.

My contention, therefore, given the changes in the energy world, is that Fools can do little harm by leading with the likes of ExxonMobil and Chevron in their investment mixes. Both companies are well managed, both offer a solid mix of oil and gas reserves, and both are globally diversified. At a time like the present, that combination could benefit investors nicely.

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Fool contributor David Lee Smith doesn't own shares in any of the companies mentioned. Chevron is aMotley Fool Income Investorpick, and the Fool owns shares of ExxonMobil. Try any of our Foolish newsletter services free for 30 days. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.